Pay-to-Play Law Update: Political Activity Can Put Government Contracts at Risk

Pay-to-play laws restrict or prohibit businesses, as well as their owners, officers, and in some cases, their employees, from making political contributions (the “pay”) if they have been awarded or are trying to obtain government contracts (the “play”). These laws, which are found at the federal, state and local levels, are an outgrowth of government contracting scandals and can strike at a company’s bottom line by disqualifying bids and voiding contracts. Violations also can result in fines, damaging publicity, and even jail.

Government contractors should have a pay-to-play compliance plan that takes into account the jurisdictions where covered owners, officers, and employees are located, and where the company does or seeks to obtain business with government agencies. In addition, contractors should have a process for training covered employees, a mechanism for pre-clearing contributions, and protocols for meeting registration and ongoing reporting requirements.

Here are a few questions to help determine whether pay-to-play laws pose a risk to your business:

Do pay-to-play laws apply to my business activities?

If so, which affiliated individuals and entities are subject to the law?

What are the consequences for covered individuals and entities (prohibitions, reduced contributions limits, reporting, other)?

What are the penalties for violating applicable pay-to-play laws?

Do pay-to-play laws apply to my business or firm?

If your business model includes contracting with federal, state, or local government bodies, you may be subject to pay-to-play laws. These laws, however, vary considerably from one jurisdiction to another. Some apply only to certain types of businesses, such as state licensees, companies receiving contracts from redevelopment authorities, or casino operators. Some laws apply to all types of contracts, including grants and real estate leases, while others apply only to contracts awarded through a competitive bidding process. Most pay-to-play laws are limited to contracts or grants over a certain dollar threshold, which may apply to a single contract or to a series of contracts.

While in recent years many campaign finance restrictions have been loosened, either by legislatures or the courts, pay-to-play laws have proliferated and, thus far, have been upheld by the courts. Pay-to-play laws have been adopted by approximately 20 states and dozens of major municipalities, including Los Angeles, New York, Philadelphia, and numerous cities and counties in California and New Jersey.

Which affiliated individuals and entities are covered?

Once you have determined that certain pay-to-play laws apply to your business, the next step is to identify which affiliated individuals and entities are affected. Most pay-to-play laws cover the contracting entity’s officers, as well as individuals whose ownership interests are above specified levels. Other laws cover employees who represent the contractor in negotiations with government agencies, as well as their supervisors. It is also common for pay-to-play laws to contain anti-circumvention provisions by applying contribution restrictions to spouses and other family members of covered owners, officers, and employees, parent and subsidiary corporations, and hired lobbyists.

For companies with a multi-state footprint, an effective approach often entails compiling a list of all individuals and affiliates who are subject to at least some, if not all, applicable pay-to-play laws. With that list in place, the company can ensure that each of these individuals and entities receives training and periodic updates about the law, has a pre-clearance system in place to screen political contributions, and collects appropriate information to help the company comply with its registration and reporting obligations.

What are the consequences of being subject to pay-to-play laws?

Prohibitions and LimitationsThe most common type of pay-to-play law limits or prohibits political contributions. As described above, the entities and individuals subject to the ban or restrictions vary widely. The period of time during which contributions are restricted varies as well. Many jurisdictions, such as New Jersey and New Mexico, include a “look-back” provision, where contributions made during a specified period prior to the contract award will either disqualify the bidder from receiving the contract or require disclosure as part of the bidding process. Other jurisdictions, such as Connecticut and the city of Philadelphia, apply a contribution ban for a specified period after the contract has been fully performed or until the awarding official (the mayor, for example) has completed his or her term.

Registration and ReportingSeveral states and municipalities require contractors to register their contracts and file periodic disclosure reports with the relevant election board.

While registration and reporting may be less onerous than contribution restrictions, they still impose significant regulatory burdens. For example, Maryland requires a business that receives a state or municipal contract to register with the state election board and then file semi-annual reports disclosing contributions made (and solicited) by covered individuals, including officers and directors, as well as by affiliated entities. To meet this disclosure burden, the filer’s CEO or designee must either survey covered persons for reportable contributions, or have a process in place that requires covered individuals to preclear their contributions through a corporate legal or compliance department.

Federal Contractors

Federal law prohibits contractors from making any contributions to officeholders or candidates for U.S. House, Senate, or President. This mainly applies to individuals, partnerships, and limited liability companies that are contractors, because all corporations are already prohibited from giving. The federal law, however, allows corporations that are contractors to form political action committees and solicit voluntary contributions from company executives. Partnerships, LLCs, sole proprietors, and individual contractors do not have this option, so they must be very careful about political giving.

Penalties

Violations of pay-to-play laws may result in disqualified bids, cancelled contracts, and even debarment. Because pay-to-play law provisions are frequently memorialized in government contracts, non-compliance can also put your company in material breach of contract.

Companies may also face civil penalties — ranging from $50 per day for late filings to $5,000 per violation — for more severe violations, such as making a prohibited contribution. Most jurisdictions provide for higher penalties if a violation is found to be knowing and willful.

Approaching Compliance

An effective compliance program can dramatically reduce the risks posed by pay-to-play laws. This starts with a review of where the company is doing (or expects to do) business, and where covered personnel are located. From there, companies should do a risk assessment, which might range from analyzing a single jurisdiction or business unit to a company-wide legal audit, depending on the scope of your governmental contracts and other business.

Most compliance programs include training and periodic reminders to covered personnel. (Some pay-to-play laws require written notice.) A process for pre-clearing contributions should also be implemented, along with a protocol for registration and ongoing reporting. Since preventive measures are imperfect, an independent, we recommend a periodic review of campaign contribution databases. Under some pay-to-play laws, if an unlawful contribution is identified and refunded within a prescribed period, no penalties will be imposed.

Trends and Developments

Certifications and AffirmationsState regulators increasingly require a business’s officer, sometimes even the CEO, to certify the accuracy of disclosure reports under penalty of perjury. For example:

The New Jersey Election Enforcement Commission amended its annual BE (Business Entity) Form to require such a certification, along with a certification that the contract was “awarded pursuant to an open and fair process.”

In a June 2016 letter, California’s Treasurer, John Chiang, notified underwriting firms of a new requirement: Any contracting entity or its officer that is part of California’s official underwriting pool must now make “an affirmative statement that [it] will not make any cash or in-kind service contributions . . . to promote or facilitate any bond campaign or ballot measure in California . . .”

These are but two examples of regulators ratcheting up the stakes for government contractors. Now individuals filing forms in these jurisdictions have the heightened duty to ensure accuracy in their forms or face potential criminal prosecution for filing false statements.

The District of Columbia May Finally Implement Pay-to-PlayThe District of Columbia City Council has long debated pay-to-play legislation, but no bills have passed. The likelihood of passage, however, may have received a boost from the D.C. Attorney General, whose proposal failed to get out of committee in December 2016, but has been reintroduced in January 2017. This bill includes a ban on contributions by entities with D.C. contracts and a two-year timeout for new contracts if an entity makes or solicits a prohibited contribution.

A Note about Financial Services Pay-To-Play Laws

Many financial service companies contract with states or municipalities to manage government pension or retirement funds, or provide other financial services. As a consequence, these companies are covered by the state and local pay-to-play laws discussed above. But that is not the end of the story. Financial service companies may also be subject to a host of federal pay-to-play laws. These include:

Securities Exchange CommissionRule 206(4)-5, which limits, and in many cases, prohibits political contributions by investment advisors to elected officials or candidates who have direct or indirect control over governmental pension funds;

Municipal Securities Rulemaking BoardRule G-37, which prohibits brokers, dealers, and municipal security dealers from engaging in the municipal securities business if they have made disqualifying political contributions to covered municipal officials; and

Commodity Futures Trading CommissionRegulation 23.451, which prohibits swap dealers from offering or entering into a swap with a governmental Special Entity if a disqualifying political contribution was made within a two-year lookback period.

Companies and firms subject to these federal pay-to-play laws should consider some of the same compliance measures discussed above, such as pre-clearance of contributions, training, and monitoring public contribution databases. In addition, protocols should be established to screen new hires and promoted employees. These laws also regulate the use of “placement agents” and other solicitors, and impose significant recordkeeping requirements.

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If you need help in determining your obligations under pay-to-play laws or developing a compliance program, the Venable Political Law Practice can be of assistance.